Refundable Credits Have Cut Taxes for Low-Income Households

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Abstract

In 1979, federal taxes claimed 8 percent of the income of households in the lowest quintile of the income distribution. Over the following three decades, the average effective tax rate (ETR) - taxes as a percentage of income - fell by nearly half to 4.3 percent in 2005. Most of the decline resulted from a sharp drop in the individual income tax, primarily due to expansion of the earned income tax credit and the child tax credit (CTC). Because the EITC is refundable and the CTC is partially refundable, they can reduce a household's tax liability below zero and generate a net payment.

Refundable Credits

Because the EITC is refundable and the CTC is partially refundable, they can reduce a household's tax liability below zero and generate a net payment. In 2005, households in the bottom quintile had an average income tax ETR of 6.5 percent - instead of paying income tax to the government, they received net payments averaging -6.5 percent of their pretax income. In contrast, payroll taxes claimed a growing share of income over the period; the payroll tax ETR for the lowest quintile climbed by more than half from 5.3 percent in 1979 to 8.3 percent in 2005. Excise and corporate income taxes together claimed about 2.5 percent of poor households' income in both years; higher excise taxes largely offset a drop in the corporate ETR.

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